Employee Overpayment Can Lead to Problems

You may have overpaid an employee because someone entered the wrong information into the system. Or maybe the employee or his or her supervisor submitted inaccurate data. Either way, this type of error is usually easily fixable. You do have to follow certain procedures, however.

Reclaiming the Overpayment

Under federal law, you can deduct wage overpayments from the affected employee's future wages — even if the deduction causes the employee's wages to fall below the minimum wage. You neither need the employee's permission to make the deduction nor have to give the employee advance notice.

But this approach can put employees in a financial bind. Therefore, some employers exhibit more flexibility.

For instance, once aware of the overpayment, the employer notifies the employee of its intent to recover the extra amount. If it's a small amount, the employer may decide to take the full amount out of the employee's next paycheck. Deductions for larger amounts can be spread out over a series of paychecks, so as not to cause the employee financial difficulty.

Some employers give employees the option of repaying the overpayment immediately, such as via personal check or money order. Or, if the employee has paid time off available, the employer may use the PTO to offset the overpayment.

State Law on Paycheck Adjustments

Some states have wage overpayment laws, which are more generous to employees than federal laws. For example, states such as Washington, Indiana, New York and California all have laws detailing the circumstances under which overpayments can or cannot be recovered through payroll deduction.

In some states, the employer must inform employees in advance of its intent to recoup the wage overpayment via paycheck deduction. The state may require that the employer obtain the employee's written consent in order to make the paycheck adjustment. Or the state might entirely prohibit overpayment recoupment through payroll deduction.

State laws on wage overpayment are very specific; make sure you follow them to the letter.

What If the Employee Has Left the Company?

This is where things can get tricky. Ideally, you should contact the former employee and request that he or she return the money. Hopefully, the employee acquiesces. However, if you cannot reach the employee, or he or she refuses to pay back the money, you will need to decide whether it's best to take legal action or let the issue go.

Tax Implications

If the repayment happens in the same year as when the overpayment took place, the employee's W-2 should not reflect the overpayment; it should look as though the overpayment never happened. However, if the repayment is made in a subsequent year, you must issue a corrected W-2, or W-2c. In both situations, you will need to review your tax returns — such as Form 941 or Form 944 — and file the necessary amendments.

Our firm provides the information in this e-newsletter for general guidance only,
and does not constitute the provision of legal advice, tax advice, accounting services,
investment advice, or professional consulting of any kind. The information provided herein should not be
used as a substitute for consultation with professional tax, accounting, legal, or other competent
advisers. Before making any decision or taking any action, you should consult a professional adviser who
has been provided with all pertinent facts relevant to your particular situation. Tax articles in this
e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of
avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided
"as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information,
and without warranty of any kind, express or implied, including but not limited to warranties of
performance, merchantability, and fitness for a particular purpose.